American Eagle Outfitters' (AEO) CEO Jay Schottenstein on Q3 2016 Results - Earnings Call Transcript

| About: American Eagle (AEO)

American Eagle Outfitters, Inc. (NYSE:AEO)

Q3 2016 Earnings Conference Call

November 30, 2016, 09:00 AM ET

Executives

Judy Meehan - VP, IR

Jay Schottenstein - CEO

Chad Kessler - Global Brand President, American Eagle Brand

Jen Foyle - Global Brand President of Aerie

Bob Madore - CFO

Analysts

Randy Konik - Jefferies

Oliver Chen - Cowen & Company

Janet Kloppenburg - JJK Research

Matthew Boss - JP Morgan

Adrienne Yih - Wolfe Research

John Morris - BMO Capital Markets

Brian Tunick - Royal Bank of Canada

Rebecca Duval - BlueFin Research Partners

Gene Vladimirov - Nomura Instinet

Michael Binetti - UBS

Richard Jaffe - Stifel

Operator

Greetings and welcome to the American Eagle Outfitters Third Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Ms. Judy Meehan, Vice President of Investor Relations for American Eagle. Thank you. You may begin.

Judy Meehan

Good morning, everyone. Joining me today for our prepared remarks are Jay Schottenstein, Chief Executive Officer; Chad Kessler, Global Brand President of the American Eagle Brand; Jen Foyle, Global Brand President of Aerie; and Bob Madore, Chief Financial Officer. Also joining us for Q&A today is Michael Rempell, Chief Operations Officer.

Before we begin today’s call, I need to remind you that we will make certain forward-looking statements. These statements are based upon information that represents the Company’s current expectations or beliefs. The results actually realized may differ materially based on risk factors that are included in our SEC filings. We also have posted a financial supplement with additional financial details on our website.

And now, I’d like to turn the call over to Jay.

Jay Schottenstein

Thanks, Judy, and good morning.

I’m pleased with our third quarter results. We achieved record sales and double-digit earnings growth consistent with our guidance. Third quarter revenue grew 2% and EPS increased 17% to $0.41 compared to EPS from continuing operations of $0.35 last year. American Eagle and Aerie achieved positive sales and healthy margins. We maintained favorable sourcing costs, expense controls, and managed inventory well. As I said a while back, consistent performance is our priority. And I’m pleased to report that this quarter marked our ninth consecutive quarter of profit improvement. These results are especially noteworthy given the challenges and rapid transformation that are taking place in our industry. We’ve been winning in a tough environment and we need to keep winning.

We’re working hard to propel our brands forward and deliver a differentiated experience across channels. To that end, our priorities are squarely focused on the following: One, product leadership. We must deliver the best innovation, quality, outstanding value to our customers day-in and day-out. Two, strengthen the brand, customer experience, and engagement. Aerie is new campaign and brand platform are critical steps towards the future. Three, growing Aerie to be a leading intimate brand of choice for today’s modern women. We continue to see great momentum in Aerie and are extremely excited by the future growth potential. Four, we will leverage our omni-channel capabilities and strong store fleet to gain market share, maximize profitability, and gain efficiencies. Five, global expansion is the significant opportunity. We will accelerate growth through high ROI license stores partners utilizing partners with strong market knowledge and customer [indiscernible]. Six, we’ll also continue to strengthen our financial disciplines and focus on ROI based investments.

I’m pleased to announce that over the past several months, we’ve hired seasoned talent to new and existing leadership roles, bringing fresh perspective and important capabilities in the areas of digital, international, marketing, human resources, and finance. Together with our highly experienced tenured executes, we have tremendous confidence in our team. We have the skills and visions to drive success in today’s marketplace.

We have a new member of the team joining our call today. I’d like to introduce Bob Madore, Chief Financial Officer. Bob brings outstanding experience to consumer retail, strong financial acumen, as well as strategic vision. I know he will be instrumental driving future success and strong return to our shareholders.

And finally, we’re encouraged by the start of the holiday season. We are well-positioned, ready to compete, and win. Looking ahead, we remain intensely focused on top priorities. I’m confident we can continue to deliver consistent profitable growth.

Thanks. And now, I’ll turn the call over to Chad.

Chad Kessler

Thanks, Jay. Good morning, everyone.

In a tough retail environment, the American Eagle Brand delivered solid results. We achieved a slightly positive comp and maintained healthy merchandise margins. This was achieved against an 8% comp last year. Our digital business was particularly strong as more and more customers shop through our mobile channel. We drove quality sales with higher realized prices as our customers responded well to product improvement. Promotional activity was controlled and targeted, yet up slightly against a strong and significantly less promotional third quarter last year.

American Eagle Bottoms continued to dominate where we achieved consistent sales growth, record volume, and margin improvement in both men’s and women’s, leading product innovation, distinguished American Eagle Jeans, and Bottoms in the market. Our customers recognized the consistency and value the team has delivered.

We also saw positive results in our women’s business and achieved a comp increase in the mid single digits in the third quarter. We saw very good strength across the collection with a positive reception to fashion and more timely deliveries of emerging trends. Additionally, we continued to see strong demand for new fabrications and tops. As an example, our recent line of Ahh-mazingly Soft shirts has been an outstanding product line.

Consistent with the trend all year, men’s tops is a bit more challenging. As a result, our men’s business declined in the mid-single digits. While I was disappointed with the performance, I am working hard with the team to make improvement. We are focused on bringing the same level of product innovation, value, and fashion to the men’s business what we have established in women’s.

As I have discussed in the past, our priorities over the past few years have been rooted in product, process, people, and presentation. We have been realizing the benefits of those priorities and remain intensely focused on building on our success. I would say over the past few years, we have made very good progress bringing together outstanding teams and have a stronger process now in place. We have been faster and more reactive to emerging fashion trends, and we have instilled innovation and product leadership as a core principle on our product development process. At the same time, I am proud of how the team has driven our cost down while consistently improving quality and value. Yet we are far from perfect and have more opportunity for improvements in category growth.

On brand strength and presentation, during the third quarter, we launched our much anticipated We All Can brand platform. This campaign authentically empowers young people and celebrates individuality. I hear from customers, our field team, and even the campaign cast how powerfully this message is resonating. As we move forward, we are well-positioned to leverage our strength as the leading domestic apparel brand to become the global resource for casual American style. We will leverage our market-leading jeans and bottoms business to build a global reputation for great fits, quality, value, and innovation. It’s a big opportunity for us and clearly a focus over the next several years.

Now, regarding the holiday season, I was very pleased to see the results over Thanksgiving. I want to congratulate the entire AE team on delivering solid results. Our brand is strong and growing stronger. Our desirable product and terrific store execution delivered the excitement and value our customers are looking for. Today, we deliver a new online product capsule to feed customer demand. We are also delivering a robust Spring Transition floor-set in mid December to drive excitement and margins around peak holiday selling. We have less than a month to go until Christmas. As the results come in, they reinforce that we are focused on the right priorities. We have enormous opportunities still ahead and we look forward to future success.

Thanks. And now, I’ll turn it over to Jen.

Jen Foyle

Thanks, Chad, and good morning, everyone. Aerie had another great quarter. Our momentum continued with third quarter marking the sixth consecutive quarter with comps over 20%. Our comps showing [ph] 21% following a 21% increase in the third quarter of last year. We saw strength across all channels and that continued to gain new customers, which rose 15% in the quarter. Traffic and transactions increased in standalone stores and online.

Quality of the sales metrics were favorable including a higher average unit retail and strong conversion. We achieved positive sales in bras, undies, and apparel. Bralettes and novelty fashion items continued to post strong results. I am extremely pleased we have led [ph] an exciting new fashion trend such as our innovation around the bralettes where we continue to see great momentum.

Additionally, this fall, we had an incredible response to the launch of our new yoga inspired line, Chill. Play. Move. The collection exceeded our expectations. We are excited about our customers’ initial response and we will build on that line, expanding customer choices in the upcoming seasons.

The digital business has been remarkable and we continue to focus on strengthening our core store base. I am pleased with the performance of our new store design. 70 standalone stores are generating productivity at 50% above older formats. We are on track with our expansion plans and we will end the year with 10 to 15 new format stores. We plan to open 25 next year with at least a third of them in new markets. On December 8, we are opening up a new pop-up Aerie location on Spring Street in SoHo. This store will feature a complete brand experience. We’re thrilled to have a presence in New York and to build brand awareness for Aerie in such a great location.

We continue to be excited with the positive customer response and growing enthusiasm around our AerieREAL campaign. I am so proud that Aerie was active sponsor of the Glamour Women of the Year conference a few weeks ago. Our spokesperson and model Iskra Lawrence attended along with the team to talk about women empowerment, confidence and body positivity. It was an absolute thrill to be part of the event and for Aerie to be honored with such an amazing group of women. Although we still have a weeks to go, we’ve been encouraged by the holiday season. Our customers are embracing Aerie’s unique gift giving items and our magical and real taste on the season. Thanks to my team who have done an amazing job and we look forward to continuing our growth plans and driving on the business momentum.

And now, let me turn it over to Bob.

Bob Madore

Thanks, Jen. Good morning, everyone. This marks my fifth week at American Eagle Outfitters. I am thrilled to be here and to be part of this fantastic organization. We have a great team and strong brands. I am excited about the many opportunities ahead. I already know many of you and I look forward to seeing everyone soon.

In a tough retail environment, the team delivered a solid third quarter. Comp sales increased reaching record total revenue in the quarter, margin strengthened, and expenses were well-managed, leading to 8% growth in operating profit.

Now, looking at the details of the quarter. Total revenue increased 2% to a record $941 million from $919 million last year. Consolidated comp sales increased 2%. This follows a positive 9% comp last year. The sales increase was driven by strength in our digital business fuelled by rapid growth in the mobile channel where traffic and conversion have been very strong. On a consolidated basis, transactions declined while average transaction size increased due to a higher average unit retail price and higher units per transaction.

Total gross profit increased 3% to $378 million from $368 million last year. The gross margin rose 20 basis points to a rate of 40.2% revenue. The increase was the result of improved IMU, partially offset by slight increase in markdowns. Buying, occupancy and warehousing costs were flat as a rate to sales.

SG&A dollars were down slightly to $220 million and leveraged 60 basis points to a rate of 23.4%. Increased investments in advertising were offset by disciplined expense management. Depreciation and amortization increased 5% to $40 million, deleveraging 10 basis points to 4.2% as a rate of revenue. The increase in D&A largely stems from technology and omni-channel investments which have shorter useful lives.

Operating income rose 8% to $118 million from a $109 million last year and the operating margin expanded by 70 basis points to 12.6%, the best third quarter rate we’ve experienced since 2012. In the third quarter, the tax rate was 36.3%, down 50 basis points compared to last year. Our share count declined by 12.9 million shares due to share repurchases late last year, which had an impact of $0.03. Earnings per share of $0.41 increased 17% from $0.35 from continuing operations last year.

Turning to the balance sheet. We ended the quarter with inventory at cost of $493 million, up 3% from last year and consistent with our expectations. The ending average unit cost was up 8% due to product mix and continued investments in merchandise composition. Like-for-like, average unit cost was down the last year. Ending units were down 5%. We ended the quarter in good shape with clearance inventories down to last year’s level -- versus last year’s levels.

Looking ahead, we expect fourth quarter ending inventory at cost to be up high single digits. Units are expected to be down with average unit cost up, consistent with our merchandising initiatives. We are comfortable with our inventory levels and composition in currency.

We ended the quarter with $292 million in cash compared to $363 million last year. Our lower cash balance was a result of $212 million in the share buybacks in the fourth quarter of last year. In addition, over the past year, we returned $92 million in cash dividends to shareholders and spent a $152 million in capital expenditures.

In the third quarter, capital expenditures totaled $47 million and a $108 million year-to-date. We continue to expect CapEx to be approximately $160 million for the year, with nearly half related to store remodeling projects and new openings, and the remaining half supporting digital and omni-channel investments and initiatives.

During the quarter, we opened four American Eagle stores, six Aerie stores and one Tailgate store. In the same period, three American Eagle stores were closed. Additionally, there were eight international licensed store openings and three closures, ending the quarter with a 163 licensed stores across 23 companies. We’re on track to close approximately 25 to 30 underperforming stores this year upon natural lease expiration. We have a good amount of flexibility in our fleet with over 500 store leases expiring in the next two years with a 185 in the next 12 months alone.

Now, regarding the fourth quarter. Although we posted solid results over the holiday period and we’re encouraged by the customers’ response to our collections, we still have a good bit of business ahead of us in the quarter. The retail climate, particularly in malls is tough and the pace of traffic is choppy. We therefore are taking a cautious view.

At this time, we’re providing fourth quarter earnings per share guidance of $0.37 to $0.39, which is based on comp sales in the range of flat to low single digit increase. This guidance excludes potential impairment and restructuring charges. This compares to an adjusted earnings per share of $0.35. Last year’s fourth quarter recorded earnings per share of $0.42 and included approximately of $0.07 of non-recurring items. As a reminder, in the fourth quarter of last year, we had a gain on the sale of a distribution center of $9.4 million, which was included in SG&A expense. Additionally, the tax rate was 27.9% in the fourth quarter of last year, as a result of income tax settlements, federal tax credits and tax strategies. This year, we expect the fourth quarter effective tax rate to be approximately 35%. Please refer to page 15 of the financial handout for summary of these items.

In conclusion, we have a great foundation in place at American Eagle Outfitters. We have well-positioned brands, tremendous international opportunity and a best-in-class omni-channel infrastructure. I’ll be working with the teams to continue strengthening the brands and ensuring we are focused on driving improved quality sale metrics. We continue to instill strong financial disciplines and return on investment based investment decisions.

And lastly, we will continue to focus intensely on our top six priorities which Jay outlined, to drive profitable growth and ensure that we are well-positioned to compete and win in today’s challenging and changing retail environment.

Thank you. And now, we will take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Randy Konik with Jefferies. Please proceed with your question.

Randy Konik

I guess I want to ask, Jay, a couple of questions, just medium-term thinking. So, it’s very pleasing to hear about the continued strong comps at Aerie, and we have done some work where if you look at where the Company has or the brand has a strong store presence, you seem to do very well from search interest perspective versus your key competitor. So, you’ve taken down the store count, you are now re-growing it. How do you think about your market share -- market penetration from a physical store perspective over the next, let’s say, three to five years? How do you think about grasping more of that market share on this momentum you are building? And also, if you could expand upon the idea of do you want to get more into apparel again where one of your key competitors has a heavy apparel business within that intimates category.

And then, I guess the second question, medium-term thinking, it was -- you have spoken about that really strong real estate flexibility you guys have over the next few years. And you talked about in your opening remarks about the changes that are going on in the industry. How do you think about the physical presence of the business from a store standpoint and internet optimization over the next three to five years, just how you think it all plays out for your business versus the industry? Thanks.

Jay Schottenstein

Okay. That’s a big question. The way we look at it is in the Aerie area -- and this will also go for like American Eagle too, is that we look at the storage, you have to look at omni business at the same time. You have to look at the online and you have to look at the stores. And we are in the process of taking certain markets and localize in those markets and figuring out in those markets where the extra opportunity is. We may have certain markets where we have mall presence; we don’t have certain street presence where it may make sense to have that street presence. So, we are taking our most productive markets and we’re starting to do certain testing in them to see can we increase the bottom lines in that market, not just to by a store by store basis, by the market itself, taking the online business in account and seeing how we maximize the bottom line for this particular market. So that’s the plan that’s being put in right now -- strategy is being tested right now.

On the Aerie side, we see a big opportunity. We know some of our competitors are giving up certain businesses that we think could be a particular opportunity for us and we will be kicking some of that off this coming spring. At the same time, we introduced this past season like the compression pants in Aerie that’s been very well received. So, we see there is plenty of categories that can be added to Aerie. And Jen and the team are working very hard on identifying what particular categories are to be added and maximizing the return right away on. We also believe that there is plenty of growth for Aerie; as far as the markets go, we have plenty of opportunity to grow there. At the same time, it is a developing business. There are categories that we don’t carry that we think in the future will be very good for the Company. And it takes time; you don’t do it overnight. The same with American Eagle, even though American Eagle is more a seasoned company, we see opportunities in different categories. And between Chad and myself and the team, we keep pushing each other to see where those categories are and how fast can we get them tested and get them rolling. Right, Chad?

Chad Kessler

Yes.

Operator

Thank you. Our next question comes from the line of Oliver Chen with Cowen & Company. Please proceed with your question.

Oliver Chen

Great collection here in denim and the Skindigo and the Super Super Stretch really the best in the mall. We just had a question regarding the guidance, because the comparisons do get easier, and you sounded very pleased with Thanksgiving. Are you still expecting average unit retails to be uppish and are transactions kind of the riskier point? And then, as we -- you gave some nice color on the inventory plans, just could you elaborate on the average unit cost in terms of what’s happening with the mix and how you are evolving that? Thanks.

Bob Madore

Yes, sure. Oliver, I’ll take that question. Yes, we are expecting average unit retails to continue to be up year-over-year. They were up mid-single digits this quarter; we are expecting the similar performance not only in Q4, but as we look to FY17, which we’re deep in the middle of our budgeting process as we speak. We do expect transactions to be pressured. Transactions were down mid-single digits this quarter, and we are expecting a similar performance looking out to Q4, and it’s incorporated within the guidance that we gave.

Regarding average unit cost, we are putting additional make into certain categories of our products, which is driving up our average unit cost. But having said that, with our average unit retails going up to the levels they are, it’s driving gross margin rate improvement year-over-year, quarter-over-quarter. So, we believe, it’s a very healthy mix in light of very challenging retail environment, and we are winning relative to our competition, which is what we are striving to do and will continue to do. We got innovative products. The consumer sees the quality; they are paying for the quality. But when you look at where our price points are, we’re not pricing ourselves out of the marketplace at all. So, we think it’s a strategy that serves us well, and we’re going to continue down that road going forward to Q4 and looking at FY17.

Operator

Thank you. Our next question comes from the line of Janet Kloppenburg with JJK Research. Please proceed with your question.

Janet Kloppenburg

Good morning everyone, and welcome Bob.

Bob Madore

Thank you.

Janet Kloppenburg

I wanted to ask, Jen, just quickly on bralettes.

Bob Madore

Can you speak up a little, Janet?

Jay Schottenstein

Yes. You need to talk up a little bit; we can hardly hear you.

Janet Kloppenburg

Okay. Is that better?

Jay Schottenstein

Yes.

Janet Kloppenburg

I wanted to ask Jen on bralettes; is this a fashion moment or is this category here to stay? And Victoria’s Secret has been very promotional in that area. And I’m just wondering if you’re feeling any promotional pressure as a result of that. And Chad, if you could just talk about the women’s business a little bit; is the strength in comp coming all from bottoms? Maybe you could just talk a little bit about the tops versus bottom growth that you’re seeing there. Thanks so much.

Jen Foyle

Hi, Janet. How are you?

Janet Kloppenburg

Good. How are you?

Jen Foyle

Very well, thank you. Regarding bralettes, I feel really good about the category. We really launched that category first; I think I said this on one of the last calls. And we sort of own that category. So, I feel really proud of that. That said, Janet, there is a whole runway here as far as the lightly line category and unlined categories that I think are going to be strong and will continue to be strong, because what’s nice about these categories is they really live by our DNA AerieREAL, so, being a little bit more true to your body and you silhouette. That said, yes, competitors were highly promotional. And what I’d like to say on that is we held our own. We price pointed bralettes where we have been in the past and which is our ground. And we saw a great momentum in bras over green. [Ph] So, really proud of what the team did and our quality and price value equation is really strong. And I think the customer sees that.

Chad Kessler

Janet, turning to women, thank you for giving me a chance to talk about women’s apparel, because it’s really so much more than just bottoms. The women’s top business has been accelerating, accelerated through third quarter, and I still feel really strong about it. We’ve built a new team over the last couple of years in both design and merchandising, and that’s really hit their stride and is just fantastic and their performance I’m very pleased with. And it’s really about balance for us. We’re seeing performance in women’s apparel across the departments, across the silhouettes. The customer I think -- we know our customer loves our bottoms. And I think they’ve finally -- are realizing that we offer the same level of innovation, quality, value and trend right fashion within tops. And I’m very pleased to see the balanced performance. I mentioned the shirts on the call, the flannels, and those have just been -- the customers are just in love with that; it’s been great.

Operator

Thank you. Our next question comes from the line of Matthew Boss with JP Morgan. Please proceed with your question.

Matthew Boss

Thanks. On the mid single-digit traffic decline in the past two quarters, what’s actually driving the negative inflection that you’ve seen? And then, just on the holiday season, what did you see in the first part of November versus what you saw over that Black Friday weekend, and just any insights that you could provide as we think about December and beyond?

Jay Schottenstein

Yes. So, on the mid single digit traffic decline in the past two quarters and what’s driving the negative inflection, I’m not really certain what that refers to. It’s been a trend that we have experienced for a little while now. The good news -- and we don’t necessarily typically give any inter-quarter performance, but how they are such a big piece of our business this quarter, I can give you some indication of how we performed. We did see an improvement in the traffic trends over the holiday period where we have been tracking mid single digits that reverted to a single digit decline, which was fantastic. And we experienced positive comps in the quarter, which is contrary to the traffic levels that were experienced in the mall. We have been trending similar to the mall traffic rate. So that was the huge break for us in the holiday. And I just think it speaks to quality of our product being trend right and the perceived value that the customer sees in that.

Operator

Thank you. Our next question comes from the line of Adrienne Yih with Wolfe Research. Please proceed with your question.

Adrienne Yih

Good morning. Great execution in a very, very difficult environment. Chad, I am going to piggyback off of Janet’s question about the fashion appeal. Can you give us some perspective on how strong you think it is, how you builds into spring and then the follow on as we move from early adaptor into more saturation mode, maybe next year, if you could give us some color on how you think about that? Jen, congratulations, 20 comps is best in the space, I mean in the whole sector and the mall; so, congrats there. Can you talk about the longer range store footprint; how big you think Aerie can be over time? And then, finally, Bob, merch margin, can you just talk a little bit about that in the third quarter and then how we should think about that gross margin, what’s implicit in the Q4 guide? Thank you very much.

Chad Kessler

So, in terms of women’s apparel, again, I just want to reiterate, we are really excited with what we’re seeing in women’s apparel. And we do see great balance across the departments. And I think we are also starting to see -- I think there is a lot of conversation out there, things where you are getting to around some of the silhouettes changing. We have -- our customer base is still, majority of our business is still a bigger top of our smaller bottom and we felt hell a lot of jeggings. So that’s not such a bad place to be. But we have got -- the way our process is built, I am confident that we will find the right balance as those silhouettes shift with our customer, not only how we test our top but also with the size of our bottoms business. We are really getting indication of where the customer is moving on the bottom, and where she is moving on the bottom can help give us an indication as where we need to -- how we need to compete off of with what we have on top.

Right now, we do have a balance in terms of fit and we are seeing some of the smaller tops beginning to turn on. I personally think it looks great. So, I am excited to see that change. But we have -- I think we have so much insight from the customer through the breadth of our assortment, through the pace of sales to start seeing how trends shift and now also through our testing process. So, I am excited to see us change in that silhouettes. I think it’s a great opportunity anytime the customer needs to update our closet. So, I am looking forward to it and I’m confident that we will pace it as well as anyone.

Jen Foyle

And Adrienne, thank so much for the compliment. We are pleased with the results as well. Looking at the store front, we planned to open 25 standalone stores next year that will be slightly smaller than our current, the original footprint which was an average of roughly 3,800 to 4,100 square feet. We are seeing really nice results from our smaller footprint and certainly, we are going to take advantage of that. I think the biggest conversation here is what Jay said that we have to look at this from an omni approach. So, the nice thing is we still only have 87 standalone stores in front of us. So, we are not over-penetrated and we are going to evaluate each market as a holistic approach to an omni share approach where we are going to invest indirect as well in that market. As a remainder, we are highly focused and concentrated in 11 states only today; and where we see that concentration we see great results on online as well as those places that we have mature market presence. And lastly, I guess I would say is thinking about AerieREAL and that just incredible platform that we have, there is amazing road ahead of us, using that platform to gain market share.

Bob Madore

Yes. Adrienne, this is Bob, just to your question on merch margins. As I pointed out, we experienced a 20 basis-point improvement this quarter. Looking forward to Q4 guidance, we are expecting gross margin rate improvement to continue, and probably at a more significant level than we experienced in Q3, really driven by a couple of things. We continue to experience lower average unit costs and like for like product really driven by decreased raw material prices, cotton and fiber costs et cetera in addition to our ability to negotiate lower cost due to oversupply or overcapacity in the marketplace.

The other thing that’s driving a healthier margin in Q4 relative to the guidance we gave is that last year, in Q4, we had a significant number of clearance units that we had to work through. Our inventories were much tighter this quarter. As I pointed out, our units are down 5% at the end of Q3 and we are not going to go into Q4, we’ve not gone into Q4 with that same level of clearance inventory, which is also going to helps us too. Combined with continued improvement in average unit retails and that’s driving the improved results.

Operator

Thank you. Our next question comes from the line of John Morris with BMO Capital Markets. Please proceed with your question.

John Morris

Thanks. Good job in a difficult environment, which is sort of my first question. Maybe, I guess a little bit of the elephant in the room is these Aéropostale liquidation -- inventory liquidation sales that are going on. So, Jay, just wondering if you can kind of give us your take on that; I mean, is that something that did feel a little bit of attention and factor into kind of the traffic numbers you guys saw? And then, Chad, the new floor-set coming mid-December, is that incremental; what might we see there; what’s a little bit different? And then finally, on Jen, maybe talk a little bit about the new pop-up in SoHo with the new brand experience, and what’s different about the brand experience that we should expect there? Thanks.

Jay Schottenstein

On the Aéropostale, the process of joint store closings is that -- then they’re going to have like store reopening. Remember, the store closing, they bought the inventory at a certain price, but when they go bring the new inventory in, it’s going to be with the new cost. And they’ll have to merchandises it just like they did the way before and what’s going to be different only time will tell. At the same time, I would tell you, if you walk the malls and you look at the stores whether be their stores or our competitor stores, I thought we had the best looking stores in the malls last week. And when you also walk the store in the mall, I think that everyone is promotional, but I think ours was better value and we didn’t have to go at steeper discount as a competition.

And what’s interesting we find is that, when we look at the shopping pattern of the customer, which is our view to figure out is that when they come, we get our fair share of it. And it’s going to be a strange season, because they’re going to come but when they come, they may come on the weekend stronger, and we’re just watching it out. I mean, we’re off a great value. We’re off a great selection. And we’re constantly being like ready for the business, and when the customer comes, we’re able to satisfy and we’re getting our fair share.

Bob Madore

Yes. Just to add a little more color to Jay’s question or answer to your question, where there were Aéro stores, Aéropostale stores that were closing or closed next to locations that we had, we did see a two to four comp-point decrease in those store locations, and it clearly had an impact on traffic too. That is dissipated quite a bit as we look to Q4, and we’re not experiencing same impact, but it definitely did have impact to us in Q3. Having said that, we had strong results across the board, every single P&L line item were up, all of our -- almost all of our quality sale metrics had improved. We hit record revenues. So, I think the team has demonstrated that we’re pretty flexible with what’s going on out in the marketplace and are able to move the business accordingly.

John Morris

And Chad?

Chad Kessler

In terms of the floor-set, so, we’re doing a couple of things. One, I mentioned, we have a new online exclusive capsule that launches today, and then our trans floor-set, Spring Transition floor-set, we usually set the day after Christmas; we’re pulling that up this year. So, when we set that in the past, we see so much -- such strong reactions in new goods. The customers shopped us heavily already for holiday and through Black Friday and Cyber Monday. And so, we believe there is an appetite out there for new products, new trends, some of the new fashion that’s happening in the marketplace. And so, we’re going to transition the floor earlier this year than we usually do. We’ll still have holiday product at a great value protecting the key items there, but we’re going give the customers something new a week before Christmas, when she can no longer -- when online shipping is -- deadlines come and they have to be in the mall. We want to give them something new, something exciting that they can shop that week before Christmas and the week after. So, we’re pulling -- something we’ve done in the past, but we’re pulling it for this year. I think it’s a great opportunity to drive both sales and drive margin.

Jen Foyle

And, John -- hi, how are you, John? Around the SoHo store, the team really rallied around the store, thinking it would be a great opportunity, not to only gain some more share here in the New York area, but also it gives some global awareness since it is the highly international market. But what we’re really focused on is just creating an authentic experience. And so, that’s what I think you’re going to see. I think when we approached it, we approached it from a place of REAL. So that’s our baseline DNA. And I think the experience you are going to see is more into that shopping more face to face conversations with our customers, and also some live experiences. So, without sharing too much, I think the grand opening is going to be amazing. We have some great things in front of us with that store. We are planning weekly event. So, there is more to come there. But hopefully, you will come and see it.

Operator

Thank you. Our next question comes from the line of Brian Tunick with Royal Bank of Canada. Please proceed with your question.

Brian Tunick

I guess two questions. Just following up on the Aéropostale liquidation question, can you maybe talk about what you saw in your traffic trends among the different mall types or even on the outlet center, just curious what’s going on with you guys in the A and B and C malls? And then, we are getting a lot of questions about the Q4 comp guidance relative to your statements about the strong holiday. So, we are just making sure that primarily the comp guidance for Q4 is due to your expectation for January to be weak because you are entering with less clearance inventory, is that how we should be reconciling that? Thanks very much.

Bob Madore

Yes, Brian, so relative to traffic trends and what we are seeing in the A, B, C malls, clearly different trends across those. The A malls are low single digits; the B and C malls are anywhere from mid to high single digit traffic declines, generally speaking, across the board. And that’s been pretty consistent, I would say throughout the year; relative to the Q4 guidance, couple of things. Although we are much cleaner in inventory and we are seeing and expecting gross margin range improvements versus last year, as we pointed out or I pointed out in my opening remarks, we had $0.07 worth of earnings per share last year in the quarter due to non-recurring type items, the sale to distribution center and some very significant tax rates -- effective tax rate items that drove that down to a non-normal let’s call it 27 plus percent range versus we average on the 36% effective tax rate range. So, when you look at the compares between the guidance we gave relative to last year’s adjusted earnings per share number, we are communicating a very healthy earnings per share increase year-over-year, which I am not sure is being recognized in the reaction happening to the stock price this morning.

Operator

Thank you. Our next question comes from the line of Rebecca Duval with BlueFin Research Partners. Please proceed with your question.

Rebecca Duval

I just had a question -- few questions, first, on the markdowns. You guys always have been really good about chasing business, ordering leaner and chasing it. So, were the markdowns primarily due to unexpected drop in traffic? And then, secondly, how are you feeling in terms of being nimble, should you see additional variances in traffic trends? And then, for Jen, the Chill. Play. Move event here in Boston was fantastic. So, congratulations on that; the yoga line was great. And I am just wondering, you talked about the expansion guys, is that something we should be looking for in Q1? And then, lastly, Chad, you talked about a continuing weakness in men’s top. And I am just wondering what’s going on there. Do you think that there is just -- I mean we’ve heard that men’s categories in other another retailers’ have also been a little bit weaker than expected. I am just wondering, if you just now have an appetite for anything new or any more color on that would be great?

Chad Kessler

I’ll kind of answer point one and point three together because they relate. Part of the markdown increase we saw, I think there is some -- we believe there is some impact around Aéro, which Bob and Jay talked about, but also the men’s business was not as strong as we had anticipated. And so, we had to take a few more markdowns in those categories than we had originally planned and that drove some of the markdown rates.

In terms of men’s, the good news is we’re definitely still getting that men’s customer. Our men’s bottom business is fantastic and actually set records in Q3. So, we know we are getting the men’s customer in the store, and they are converting and they are buying the bottoms. So that’s good news. The challenge is we just haven’t seen a turnaround that I have been hoping for all year in the rest of the men’s apparel categories. And I am working really closely with the team on that. I do think, as you mentioned, I don’t think anyone is out there shouting that how fantastic their men’s business is. We have come off some strong years of men’s growth, and I do think there hasn’t been that much compelling units. I think that what we are delivering going forward is more compelling, it’s I think more fashion forward with some of the active trends that we are seeing out there and some of the active fabrications that we are seeing our customers want to. So, we are working to bring the same level of innovation, value and fashion in men’s that we bring in women’s. And I am hopeful that we will start to see more of a turnaround there. But so far, the softness in men’s in Q3 did lead to some of the increase in markdowns.

In terms of nimbleness, I am -- the team continues to amaze me at how fast we can get into stuff and get out of things, across the board. The supply chain that we built is quite fast and quite nimble at both helping us with upside and downside and that does help us even in the men’s business, reacting inventory levels throughout the rest of the season. But then, even have been raving about the women’s business and looking at how fast we got stuff -- real stuff that we set for holiday initial in November, that’s going back. We got amazing reads and that’s goods are falling back in the stores this week. So, even for the scale and size of our business, our supply chain can really help us impact sales even within the quarter. So it’s fantastic.

Jen Foyle

Rebecca, how are you? Thanks by the way for attending that event; that was a great event by the way. We got a lot of great hype on that event, and it was exciting and the marketing team certainly did a great job there. Around yoga, we went out it very aggressively in September and there is always learnings to take away but we had nice results, as you can see in the comps from Q3. We are looking to grow this business. As Jay mentioned, we are going to grow some of these ancillary businesses. And the nice thing is that we have other businesses. So, we have swim, we have sleep in Q4 and we are a lifestyle business, and that’s what I love about Aerie. It’s how we show up in these categories that sometimes aren’t so unique. So yoga is out there in a big way right now. But I think the way we are playing in that gain is very different and the way we are showing up and we will continue to do that.

Operator

Thank you. Our next question comes from the line of Simeon Siegel with Nomura Instinet. Please proceed with your question.

Gene Vladimirov

Good morning, guys. This is actually Gene Vladimirov on for Simeon. Thanks for taking my question. I was wondering how we should be thinking about the SG&A spend into 4Q and next year, if you could talk a little bit about your flexibility there; and then, specifically, any color on the marketing spend in 4Q and how that may compare to 3Q? Thanks.

Bob Madore

Sure. So, looking to Q4, you should be expecting SG&A spend to be up slightly low single-digits. And then, looking to next year, as I said, we’re right in the middle of our budget process. I’m four weeks into it. But, I can tell you that we’re definitely targeting ourselves to experience SG&A rate leverage next year for sure. I can’t really give you the exact range right now as we’re working through a few things. And then, relative to Q4 SG&A and advertising spend specifically, we will see a slight increase in spend versus last year, and that’s going to drive SG&A deleverage, slight deleverage in the quarter. That’s pretty much the answer.

Gene Vladimirov

Great. Thanks. Good luck for holiday.

Bob Madore

Thank you.

Operator

Thank you. Our next question comes from the line of Michael Binetti with UBS. Please proceed with your question.

Michael Binetti

Hi, guys. Good morning. I know this was -- Bob welcome to the new office. It was nice hearing from you.

Bob Madore

Yes. Hey, Michael.

Michael Binetti

So, I guess this was asked a little bit earlier, but I just want to ask again. I’m trying to understand how much longer the AUR tailwind is going to be helping you guys at this rate; I mean maybe even longer term. I know you mentioned that it should carry in to 2017, but is this something you can be carrying multiple years to help offset the traffic or how are you thinking about more of a mid range planning? And then also on bralettes, obviously, this is one of the very few clear strong trends in the space right now. Can you help us think about the category a little bit? And obviously you guys were first and furious there. How do you think about how fast the category is growing versus whether you’re taking share to help us think about the dynamic -- the competitive dynamics and sustainability of growth in that category for you?

Bob Madore

Sure. So, on the AUR question, I’ll answer that. So, definitely expecting continued AUR improvement and growth in Q4 and also for budget 2017. When you look forward to 2017 and even beyond, but with the lens really focused on 2017, the reason we’re able to do that is again the innovative product that we have, the different fabrications that we’re bringing to the table, the quality of the merchandise and how trend right our product is. When all those things are clicking, you’re able to able drive AUR increases.

We’ve demonstrated that we have the ability to do that on a sustained basis. And I would expect that when you look forward beyond 2017 that we will still continue to have some level of AUR growth opportunity. I can’t tell you specifically how much or if it’ll be sustained at the levels it is. But I do expect it to continue at some level going forward. Where it bottoms out Michael, I’ve got to get a little more experience here with the business and working with my team and my friends here.

Michael Binetti

Okay. Thanks.

Jen Foyle

Hi, Michael. Thanks for the question and bralettes, the million dollar question out there. We certainly hit on the trends, but we believe that there is a market change in the intimates business going forward. And I think Aerie plays nicely in that space. We still will own the pushup business because our campaign is AerieREAL. And there are some girls that need that level of adjustment, shall I say. So, we’ll still participate in that, but what I love about the bralette business is that like I said it ties into what we do best in that slightly lined. And we will continue to evaluate trends as we forward, Michael, and where we need to flex. And we think there are some big trends coming our way out there that we are on the pulse on. [Ph]

Judy Meehan

Michelle, we have time for one more question.

Operator

Thank you. Our next question comes from the line of Richard Jaffe with Stifel. Please proceed with your question.

Richard Jaffe

Thanks very much, guys. And if we go back to the ability to close stores and the rapid growth you’ve seen through the online channels, wondering how you view the equilibrium over the next couple of years in terms of store closings, ecommerce growth and where you are going to prioritize, both your investments and your ability to perhaps close stores?

Bob Madore

Sure. So, as I pointed out, we’ve got 500 leases with natural expirations coming up over the course of the next three years, which affords us a lot of flexibility and closing stores which are underperforming relative to our expectations without any financial implications whatsoever, lease liabilities et cetera. With the rapid growth in online channels, the one thing that we’ve definitely seen is where we have a brick and mortar presence or have established a new brick and mortar presence, it drives increased demand on digital. So, having that brand awareness within the marketplace represented by a brick and mortar store is driving an entire omni-channel experience, it’s driving incremental sales within that marketplace.

And looking at prioritizing our investments and our ability to close stores, with the size of our portfolio, I was pleasantly surprised and amazed at the small number of unprofitable stores that we have. So, it’s not a burning issue for us at all. It’s not a material financial overhang for the organization, and we are very disciplined when we are analyzing and assessing stores that are coming up for expiration as to how they are fueling the omni-channel experience. And there is a lot of in-depth analysis that goes into that decision. Even in our C malls -- our C malls stores are extremely profitable in addition to B and A. So, I don’t feel early days but I don’t feel as though we’re significantly over-stored as across the AE brand. And again, we are very disciplined about analyzing whether we want to continue with a store that expiring or not. But like I said, it’s very important to recognize, Richard, how the brick and mortar presence, fuels the entire omni-channel experience in the results within that marketplace.

Judy Meehan

Okay, everyone. That concludes our call today. Thank you for your participation and continued interest in American Eagle Outfitters.

Operator

Thank you. This concludes today’s teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful day.

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